Cash: Sitting on the sidelines

Cash remains king in the minds of many clients as they monitor the slow recovery from the global financial crisis and, as Benjamin Levy reports, it rests with advisers to tell them when the time is right to change allocations.

Investment guru Warren Buffet famously said about the global financial crisis (GFC) that only when the tide goes out do you know who has been swimming naked.

He meant it as a statement about taking excessive risks before a market downturn, but it can just as easily be applied to the predicament that some financial planners are finding themselves in at the moment.

A confidence-shattering event like the GFC has exposed the amount of control financial planners have over what their clients want, and advisers are divided about what to do with their clients’ investments.

Many financial advisers have been accused of falling victim to their clients’ nervousness and are sitting with millions in excess cash, waiting for ‘the right signal’ to invest; while others are adamant that their clients are comfortable moving back into the market — despite client research showing otherwise.

More advisers are happy to sit in cash as long as the sector offers good returns and record-high cash rates.

But fund managers and investment researchers are gnashing their teeth over what they perceive as indecision, and the choices that advisers make may yet ruin the long-term financial wellbeing of investors.

Waning influence

The GFC has shattered investors’ confidence and exposed just how little influence some financial planners have over their clients’ asset allocations. Some planners are still struggling to make their clients take more than baby steps out of the cash sector.

“It’s very hard to instil confidence in someone when the market’s just dropped 55 per cent,” says Darren Pawski, managing director of Wealthsure.

Despite the fact that some asset classes are offering better value than they were a few years ago, the equity markets haven’t recovered far enough to instil confidence in planners’ clients. Wealthsure has seen a small increase in weighting to equities, but cash is clearly still dominant, according to Pawski.

Clients are still taking a “fear approach” to their investments, he says.

The industry research houses that measure investor confidence have been united in their blunt appraisal of market sentiment, releasing data that paints a sorry picture of disheartened and pessimistic investors.

The latest Coredata Investor Sentiment Index, measured in the December quarter of 2010, marked investor confidence in negative territory, at -5.3 per cent, more than a year on from the beginning of the market recovery.

In addition, 60 per cent of respondents had withdrawn funds from their investments, but the money used to buy new investments rose by only 17 per cent.

Research house Datamonitor has forecast that the cash sector will continue to swell. Datamonitor’s February report found that the bank deposit market would grow to $694 billion in another four years, thanks to a low consumer appetite for investment risk.

More than 35 per cent of investors increased their exposure to cash products like high interest savings accounts in 2010, according to Datamonitor.

Research from Investment Trends’ Adviser Product Needs report, to be released this month, corroborates this negative outlook. Out of a survey of 700 planners, 58 per cent of respondents said their clients needed confidence that the economic recovery was real before they would re-invest their cash funds in the share market.

Self-managed super fund (SMSF) investors are also proving hesitant, with 35 per cent saying they don’t have enough confidence in the economy to re-invest their cash holdings.

The steps that have been taken since 2009 to re-invest have been paltry. Between 2009 and 2010, total SMSF cash holdings only fell by $6 billion to $34 billion.

Ninety-three per cent of planner respondents in Investment Trends’ adviser survey are holding their clients’ assets in excess cash that would normally be invested — to the tune of $55 billion.

That number has actually increased from $53 billion since their 2009 survey, suggesting that advisers and their clients might be becoming more wary of investing in the market, rather than less.

Comparisons between the GFC and the extent of the stock market crashes in the twentieth century abound, but it is the shock that investors suffered as a result of those stock market crashes that is the most compelling.

Pawski didn’t hesitate before labelling the GFC a traumatic experience for investors, and he added that its effects were still being felt.

“It’s had such a massive impact on people. It was just the sheer severity of that whole crisis, and it has affected their confidence.”

The effects of the GFC are even more severe than the stock market crash of 1974 because Australians were far more exposed to equities as a percentage of their net wealth than they were in 1974, Pawski says.

Advisers constantly struggle to convince their clients to follow a certain investment strategy when in their hearts clients don’t want to risk losing hard-earned capital; it’s part of an adviser’s job.

It’s why advisers are always encouraged to increase their communication skills and soft skills. But the GFC has made that task all but impossible.

The memory of the GFC has affected the ability of financial planners to convince their clients to re-invest in the market and take advantage of the market gains throughout 2010.

“It’s their nest egg. They would rather miss out on the opportunity of potential gains than lose further funds,” Pawski says.

Some advisers with clients that are in for the long term and understand equities and how they perform would have seen the opportunity to re-invest in the market once it hit bottom, when shares were at good value, and had good price/earning ratios. But for other planners with different clients, the fear would have been simply too much to handle.

Indeed, the Coredata Investment Sentiment Index suggests that investors are content to leave their funds in cash, with dissatisfaction with their investments dropping slightly between the September and December quarter 2010.

Fund managers are far from happy with the current situation. They have been screaming themselves hoarse telling investors to jump into the market while the going was good.

Listed funds management company Wilson Asset Management warned in January last year that investors re-entering the share market may have found that the broad upward market movement has petered out.

“The significant rally we have enjoyed since March 2009 will lose momentum as we progress into 2010,” the group stated.

In March last year, AMP Capital Investors head of investment strategy Dr Shane Oliver said the outlook for share markets was still good, with improving economic growth, low inflation and low interest rates — although there was still plenty of cash on the sidelines.

But investors must not have heard the good news — or perhaps they have heard only whispers. There are other sources of information that are competing for their attention.

The Internet has made information and news readily accessible to any investor, perhaps even more available than financial planners themselves.

Stories of unemployment in the United States, bailouts and savage government cuts in Europe, and a constant national discussion on the budget deficit (which has stayed front-and-centre thanks to the Queensland floods), is doing its part to keep investors worried. It is a sore sticking point for advisers.

“Everything you can read electronically, which you couldn’t before, and there is so much negative activity going on around the world that you are aware of, it makes it very challenging,” Pawski says.

Andrew Watt, financial planning manager and adviser with NAB Financial Planning, agrees that while there is a lot of negative information going around, both “factual and manufactured”, advisers are letting themselves become too distracted by it and losing focus on the long-term objectives of their client.

“From my perspective, we need to change the focus back to things like goals and objectives and financial needs, and a lot of those other aspects become less important,” he says.

The performance of the share market and the continuing pessimism of investors could be creating a volatile situation.

Investors appear to looking for someone to blame for their situation.

According to the Coredata Investor Sentiment index the majority of respondents believed that the Government was not providing a good investment climate, and that they could not be trusted to maintain current superannuation legislation.

Advisers being affected

It is not just clients who are displaying signs of nervousness about the state of the investment markets.

Every planner seems to have a different theory about what the markets are doing and what they might do in the future, but one thing most advisers can agree on is that the share market will be volatile for some time.

Researcher and publisher of brillient!, Graham Rich, said the nervousness was like a “contagion” affecting advisers.

“My suspicion is that there has been an excessive amount of contagion to the extent that it has made advisers nervous about their ability to be able to give good, rational reasons why investment markets have risks, but those risks can be managed. The risks can’t be managed by never going there,” he says.

Advisers may also be worried about the repercussions to their reputations and their relationship with their clients if they give advice to move out of the cash sector and another market fall occurs.

These days, even advisers who base their advice on strong arguments and a clear understanding of long-term market trends can find themselves being heavily lambasted by their clients if there is a short-term drop in the market.

The behaviour of global share markets since the end of the GFC makes that an all-too-likely scenario, and any unsatisfied client is likely to spread the word to other clients.

An adviser would have to have nerves of steel to withstand that.

Thus far, advisers appear to be happy to pander to whatever their clients want, but no matter how experienced they are, investors do not have the expertise and research that most advisers have at their fingertips to know where the best long-term returns are.

Advisers may be losing the ability to communicate their expertise and research to clients, according to Rich.

“Advice is about having an ability to discern what’s going on in the investment markets and having the courage to be able to help a client get to where they want to go by showing them the right path, which may, on occasions, be counterintuitive as far as the investor is concerned,” he says.

A lot of advisers are refusing to stand up to their clients, Rich says.

It is also possible that financial planners don’t fully understand what is going in the market themselves, and that is also making them unwilling to give advice, for fear that any subsequent market shock or underperformance will make them seem incompetent.

“If more financial advisers had a clearer and more structured understanding of what the markets are doing and what the consequences of those market changes are for portfolio construction, they’d be in a better position to be able to give investment advice,” Rich says.

Watt is adamant that no matter what the data shows, his clients are ready to move back into the market with a bit more “confidence and colour”.

“If I talked to 10 people who had cash sitting idle, I could have good solid conversation with 60 to 70 per cent of those people. We’re getting a pretty receptive process at the moment,” Watt says.

If the performance of Australia’s economy during the GFC has taught the industry anything, it is that the country is more likely to be affected by what happens in South East Asia than by what happens in Europe and the United States.

So for advisers to blame their clients’ nervousness on what is happening in Europe may be a bit of a stretch for some.

Watt is quick to point out that the performance of the Australian share market over the past 12 months has simply reinforced how remote Europe’s problems are for investors here.

“It’s not having a significant direct impact on decision-making. I think people are able to put it into context of where we are and what’s happening in Europe,” he says.

Longevity risk may also be playing a key role. Watt believes that the reason clients are ready to move back into the market has less to do with confidence in the market and more to do with rising cost pressures coupled with increasing life expectancy.

The industry has been trying to raise awareness of longevity risk for some time. Financial services company Mercer released its retirement income paper late last year, warning that longevity risk remained one of the greatest challenges for retirement income planning.

“The pressure on Australia’s retirement savings and income system in coming decades will be far greater than is presently forecast,” said David Anderson, managing director and market leader for Mercer.

Macquarie, ING and AXA introduced longevity risk products throughout and after the GFC to cater to concerns about increasing life expectancy, while the Investments and Financial Services Association announced during its rebranding as the Financial Services Council that it would be advocating for more Australians to work beyond retirement to extend their income.

The former Rudd government also acknowledged that more needed to be done in the Cooper Review about facilitating more attractive retirement income products.

There are signs that investors may finally be getting the message.

“We’re seeing rising costs of living, life expectancies are getting longer, the Australian dollar is rising, so to me, people are getting more aware of some of those economic fundamentals changing, and of course are now starting to think that they need to make their money work a bit harder, and start looking beyond cash,” Watt says.

Playing the waiting game

Some advisers are playing the waiting game with their clients. Even though they are well aware of a gradual improvement in both asset classes and market sentiment, they believe that the opportunities offered by the cash sector are more attractive than any returns from shares and are happy to wait while their clients slowly become more comfortable with re-investing in the market.

Despite concerns from industry experts and fund managers that clients risk losing out on market gains, the cash sector is still offering great returns for any investor.

The Reserve Bank of Australia cash rate has remained at almost record levels, and as always, cash offers easy liquidity — a ‘must-have’ after the GFC.

Nick Rose, a financial planner for Rochdale Financial Services and an authorised representative of Capstone Financial Planning, says the market recovery will still be there to take advantage of even if clients choose not to invest immediately.

Continuing bad news around the world means that many clients won’t yet be comfortable with investing in the market, and with a 6 per cent return on cash holdings, they can afford to sit in and wait until they are sure.

“While you can be there and advise people, it has to be something people are comfortable with, and given the amount of bad news that’s getting around, people just want to stay clear,” Rose says.

Part of the reason cash rates have been unseasonably high is because with overseas lending costing so much, the big four banks have been keen to draw in more term deposits at home to fund their activities.

HLB Mann Judd has moved to one-year term deposits for their clients’ cash allocations, with the option of further three or five year term deposits because of the good cash rates on offer, according to Michael Hutton, partner at advice firm HLB Mann Judd.

Another factor contributing to clients’ reticence in moving back into the market is the government guarantee. Instituted during the GFC and guaranteeing deposits of up to $1 million, it has ensured that investors would rather keep their funds in a savings account than invest it in the market. It is due to be reviewed in October this year, and is likely to be reduced or removed completely

“When that’s gone, I believe people will reconsider,” Rose says.

Some of his clients are just beginning to “dip their toes” back into the market, while others may be reducing their cash exposure by up to half, Rose says.

Affecting market investment?

Advisers may be happy to wait until their clients become more interested in investing back into the market, but it is clear that their tardiness is going to cause big problems for their long-term financial wellbeing.

Rich has noticed a significant outflow from the major asset classes moving into cash, nearly all of it into term deposits.

It is “far too much money”, he says.

Cash is meant to be held for three to five years, as a tactical allocation and to reduce short-term market volatility — but only in addition to investing in the share market. The wholesale dive into the cash market is a sign that advisers are dismissing the strategy of medium to long-term asset allocation.

While Rich agrees that advisers still do not have confidence in the economy or the investment markets, that argument doesn’t stack up against the evidence.

Other wealth management companies have noticed the trend to cash and are shifting their priorities to take advantage of it.

In August last year, the chief executive of BT Financial Group, Brad Cooper, said the group would be focusing on wealth management growth as a result of their predictions of bank deposits and other wealth sectors such as superannuation, over the next nine years.

BT’s bank deposits were estimated to expand from $3.1 trillion last year to $5.9 trillion by 2020, an annual growth rate of 6 to 7 per cent.

The Australian equities market is on the cusp of a “golden age”, according to Perpetual’s head of investment market research, Matthew Sherwood.

The ASX is continuing to rise, hitting 5000 points last year, while the Dow Jones Index in the United States has hit over 12,000 points — the first time it has done so since the financial crisis.

The traditional asset classes of equities and bonds are showing the kind of performance characteristics that should encourage proper asset allocation.

“There is a quite consistent argument that global investment markets have recovered, or are in the stages of good recovery. While not every investment market is going gangbusters, it means that the concept of sitting in cash is not necessarily the smartest idea,” Rich says.